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It's time we do away with the notion behind the incessant flow of
stories and warnings about upcoming hyperinflation in the US. It
can't and therefore won't happen, at least not for years into the
future. It would be a lot more constructive - and necessary - to
focus on the reality we see before us than on such a purely
mythological tale. Because that's all it is. Bubbles, and yes,
that includes credit bubbles, have their own internal dynamics:
they MUST pop when they reach critical mass.

Trying to prevent the pop, or even increase that mass, is futile.
And even though that may be more about physics than about
finance, why it is so hard to understand is beyond me. The
deleveraging, a.k.a. debt deflation, has hardly begun, and it for
now remains largely hidden behind a veil of QEs. That doesn't
negate the fact that ultimately QE is powerless to stop it, even
as it sure manages to fool a lot of people into thinking it can.

The world’s major economies are struggling and their
private-sector is deleveraging (paying off debt). If history is
any guide, this deflationary process is likely to continue for
several years.

You will recall that heading into the global financial
crisis, corporations and households in the developed world were
leveraged to the hilt. During the pre-crisis era, debt was
considered a birth right and for decades, the private-sector
leveraged its balance-sheet. Unfortunately, when the US housing
market peaked and Lehman went bust, asset values plummeted but
the liabilities remain unchanged. Thus, for the first time in
their lives, people in the developed world experienced the wrath
of excessive leverage.

Today, the private-sector in the West is struggling and for
the vast majority of households, their liabilities now exceed
their assets. Furthermore, incomes have also declined (or
vanished), thereby making the debt servicing even more difficult.
Consequently, in order to avoid bankruptcy, the private-sector in
the developed world is now trying its best to reduce its debt
overhang. Instead of getting excited by near-zero interest rates
and taking on even more debt, it is now doing the unthinkable and
paying off its liabilities.

Figure 1 shows that despite the Federal Reserve’s carrot of
almost free credit, the private-sector in the US is deleveraging.
As you can see, since the bursting of the housing bubble,
America’s companies and households have been accumulating large
surpluses. Make no mistake, it is this deleveraging which is
responsible for the sluggish economic activity in much of the
developed world. Furthermore, this urge to repay debt is the real
reason why monetary policy in the West has become
ineffective.

If you review data, you will note that in addition to
the US, most nations in Western Europe are also deleveraging and
this explains why the continent’s economy is on its knees.

The truth is that such periods of deleveraging continue for
several years and when the private-sector decides to repay debt,
interest rates remain subdued and monetary policy becomes
ineffective. Remember, during a normal business cycle, monetary
easing succeeds in igniting another wave of leverage. However,
when the private-sector is already leveraged to the hilt and it
is dealing with negative equity, low interest rates fail to kick
start another credit binge.

As much as Mr. Bernanke would like to ignore this reality, it
is clear to us that this is where the developed world stands
today. Furthermore, this ongoing deleveraging is the primary
reason why the Federal Reserve’s stimulus has failed to increase
America’s money supply or unleash high inflation. Figure 2 shows
that over the past 4 years, the US monetary base has grown
exponentially, yet this has not translated into money supply or
loan growth.

At this stage, it is difficult to forecast when the
ongoing deleveraging will end. However, we suspect that the
private-sector may continue to pay off debt for at least another
4-5 years. In our view, unless the US housing market improves and
real-estate prices rise significantly, American households will
not be lured by record-low borrowing costs. Furthermore, given
the fact that tens of millions of baby boomers are approaching
retirement age, we believe that the ongoing deleveraging will not
end anytime soon. Due to this rare aversion to debt, interest
rates in the West will probably remain low for several years.
[..]

Once you realize just how enormous that gap is (see that last
graph) between the monetary base vs the money supply, and the
seemingly smaller gap between monetary base vs loans and leases,
maybe then you see a light a-shinin'. Maybe you never thought
about things that way before, or maybe you never saw it in a
graph, and you needed to see that. It surely carries a very large
argument against hyperinflation.

Puru Saxena thinks there are positive signs in US housing
numbers, that there's a bottom, and he's certainly not the only
one; that's one train everyone seems to be eager to jump on.

I’m sorry, but I think the recent alleged US housing recovery is
a proverbial soap bubble. In the article below, Tyler
Durden at ZH calls it a "subsidized bounce". He also says:
"two concurrent housing bubbles can not happen", and he
may well be right, but if he is, it means that perhaps what we
see is a bubble within a bubble, a mother and child bubble,
instead of two concurrent ones. Durden brings interesting numbers
and developments to the forefront. It would be good if more
people digest them, and only then decide whether this is a
recovery or not.

US households are not merely deleveraging, and taken as a whole
you could perhaps make a point that they're not at all. They go
one step beyond deleveraging: they're simply and plainly
defaulting.

Lately there has been an amusing and very spurious, not to
mention wrong, argument among both the "serious media" and the
various tabloids, that US households have delevered to the tune
of $1 trillion, primarily as a result of mortgage debt reductions
(not to be confused with total consumer debt which month after
month hits new record highs, primarily due to soaring student and
GM auto
loans). The implication here is that unlike in year past, US
households are finally doing the responsible thing and are
actively deleveraging of their own free will.

This couldn't be further from the truth, and
to put baseless rumors of this nature to rest once and for all,
below we have compiled a simple chart using the NY Fed's own
data, showing the total change in mortgage debt, and what portion
of it is due to discharges (aka defaults) of 1st and 2nd lien
debt. In a nutshell: based on NYFed calculations, there has been
$800 billion in mortgage debt deleveraging since the end of 2007.
This has been due to $1.2 trillion in discharges (the amount is
greater than the total first lien mortgages, due to the
increasing use of HELOCs and 2nd lien mortgages before the
housing bubble popped).

In other words, instead of actual responsible behavior of
paying down debt, the primary if not only reason there has been
any "deleveraging" at all at the US household level, is because
of excess debt which became insurmountable, not because
it was being paid down, the result of which is that more
and more Americans are simply handing their keys in to the bank
and walking away, and also explains why the US banking system is
now practicing Foreclosure Stuffing, as defined first here, as
the banks know too well, if all the housing inventory which is
currently in the default pipeline were unleashed, it would rip
off any floor below the US housing "recovery" which is
not a recovery at all, but merely a subsidized
bounce, as millions of units are held on the
banks' books in hopes that what limited inventory there is gets
bid up so high the second housing bubble can be inflated
before the first one has even fully burst.

Naturally, two concurrent housing bubbles can not happen,
Bernanke's fondest wishes to the contrary notwithstanding,
especially since as shown above, US households do not delever
unless they actually file for bankruptcy, and in the process
destroy their credit rating for years, making them ineligible for
future debt for at least five years.

It is thus safe to say that all the other increasingly poorer
US households [..] are merely adding on more and more debt in
hopes of going out in a bankrupt blaze of glory just like
everyone else: from their neighbors, to all "developed world"
governments. And why not: after all this behavior is being
endorsed by the Fed with both hands and feet.

The following graph from TD Securities ( through Sam Ro at
BI ) makes a good case for the "subsidized
bounce" definition Durden applies to the present US housing
market. It's no secret there's a huge shadow inventory
overhanging US housing, and now it comes out that those great new
home numbers are not what everybody would like to think they are.

Many more houses are built than sold. And get shoved on top of
the pile that's already there, both the shadow inventory and the
out of the closet one. Which begs the question: how long does a
home stay in the "new" category? Does it take 1 year of staying
empty for it to move to "existing"? 2 years, 3 years? 5? For one
thing, builders and developers certainly have a huge incentive to
continue to advertise it as new.

How this constitutes a recovery I just can't fathom. I think that
is just something people would like so much to see that they
actually see it. Moreover, there remains the issue that it's very
hard for most to comprehend what debt deflation is, what its
dynamics are, and what consequences it has.

We have lived through the by far biggest credit bubble in
history. It should be clear to everyone that this bubble has not
fully - been - deflated yet (and if it's not, good luck). Until
it has, economic recovery and housing recovery are pipedreams.
And so is hyperinflation, though that may be more of a pipe
nightmare. There is no way QE, or money printing, or whatever you
name it, can cause hyperinflation against the tide of a deflating
bubble. Once a bubble has fully burst, it is a possibility. But
only then. And only if and when a country has become unable to
borrow in international debt markets. Greece perhaps soon, but
for the US it's years away, if ever.

QE Ad Infinitum: Why QE is Not Reviving
Growth
In a speech in November of 2002, Fed chairman Ben
Bernanke made the now infamous statement, "the U.S.
government has a technology, called the printing press, that
allows it to produce as many U.S. dollars as it wishes
essentially at no cost," thus earning the nickname "Helicopter
Ben". Then, he was "confident that the Fed would take whatever
means necessary to prevent significant deflation", while
admitting that "the effectiveness of anti-deflation policy would
be significantly enhanced by cooperation between the monetary AND
fiscal authorities."

Five years after the 2008 financial crisis, Helicopter Ben
undoubtedly has a greater appreciation for the issues the BoJ
faced in the 1990s. The US 10-year treasury bond (as well as
global bond) yields have been in a secular decline since 1980 and
hit new historical lows after the crisis. What the bond market
has been telling us even before the QE era is that bond investors
expect even lower sustainable growth as well as ongoing
disinflation/deflation, something that Helicopter Ben has been
unable to eradicate despite unprecedented Fed balance sheet
deployment.

A Broken Monetary Transfer Mechanism

Effective monetary policy is dependent on the function of
what central bankers call the Monetary Transmission Mechanism,
where "central bank policy-induced changes in the nominal money
stock or the short-term nominal interest rate impact real economy
variables such as aggregate output and employment, through the
effects this monetary policy has on interest rates, exchange
rates, equity and real estate prices, bank lending, and corporate
balance sheets."

Yet two monetary indicators, i.e., the money multiplier and
the velocity of money clearly demonstrate that the plumbing of
this monetary transmission mechanism is dysfunctional. In
reality, the modern economy is driven by demand-determined
credit, where money supply (M1, M2, M3) is just an arbitrary
reflection of the credit circuit. As long as expectations in the
real economy are not affected, increases in Fed-supplied money
will simply be a swap of one zero-interest asset for another, no
matter how much the monetary base increases. Thus the volume of
credit is the real variable, not the size of QE or the monetary
base.

Prior to 2001, the Bank of Japan repeatedly argued against
quantitative easing, arguing that it would be ineffective in that
the excess liquidity would simply be held by banks as excess
reserves. They were forced into adopting QE between 2001 and 2006
through the greater expedient of ensuring the stability of the
Japanese banking system. Japan's QE did function to stabilize the
banking system, but did not have any visible favorable impact on
the real economy in terms of demand for credit. Despite a massive
increase in bank reserves at the BoJ and a corresponding increase
in base money, lending in the Japanese banking system did not
increase because: a) Japanese banks were using the excess
liquidity to repair their balance sheets and b) because both the
banks and their corporate clients were trying to de-lever their
balance sheets.

Further, instead of creating inflation, Japan experienced
deflation, and these deflationary pressures continue today amidst
tepid economic growth. This process of debt de-leveraging
morphing into tepid long-term, deflationary growth with rapidly
rising government debt is now referred to as
"Japanification".

Two Measures of Monetary Policy Effectiveness

(1) The Money Multiplier. The money
multiplier is a measure of the maximum amount of commercial bank
money (money in the economy) that can be created by a given unit
of central bank money, i.e., the total amount of loans that
commercial banks extend/create. Theoretically, it is the
reciprocal of the reserve ratio, or the amount of total funds the
banks are required to keep on hand to provide for possible
deposit withdrawals.

Since September 2008, the quantity of reserves in the U.S.
banking system has grown dramatically. Prior to the onset of the
financial crisis, required reserves were about $40 billion and
excess reserves were roughly $1.5 billion. Following the collapse
of Lehman
Brothers, excess reserves exploded, climbing to $1.6
trillion, or over 10X "normal" levels. While required reserves
also over this period, this change was dwarfed by the large and
unprecedented rise in excess reserves. In other words, because
the monetary transfer mechanism plumbing is stopped-up, monetary
stimulus merely results in a huge build-up of bank reserves held
at the central bank.

If banks lend out close to the maximum allowed by their
reserves, then the amount of commercial bank money equals the
amount of central bank money provided times the money multiplier.
However, if banks lend less than the maximum allowable according
to their reserve ratio, they accumulate "excess" reserves,
meaning the amount of commercial bank money being created is less
than the central bank money being created. As is shown in the
following FRED chart, the money multiplier collapsed during the
2008 financial crisis, plunging from from 1.5 to less than
0.8.

Further, there has been a consistent decline in the money
multiplier from the mid-1980s prior to its collapse in 2008,
which is similar to what happened in Japan. In Japan, this
long-term decline in the money multiplier was attributable to a)
deflationary expectations, and b) a rise in the ratio of cash in
the non-financial sector. The gradual downtrend of the multiplier
since 1980 has been a one-way street, reflecting a 20+ year
dis-inflationary trend in the U.S. that turned into outright
deflation in 2008.

(2) The Velocity of Money. The velocity of
money is a measurement of the amount of economic activity
associated with a given money supply, i.e., total Gross Domestic
Product (GDP) divided by the Money Supply. This measurement also
shows a marked slowdown in the amount of activity in the U.S.
economy for the given amount of M2 money supply, i.e.,
increasingly more money is chasing the same level of output.
During times of high inflation and prosperity, the velocity of
money is high as the money supply is recycled from savings to
loans to capital investment and consumption.

During periods of recession, the velocity of money falls as
people and companies start saving and conserving. The FRED chart
below also shows that the velocity of money in the U.S. has been
consistently declining since before the IT bubble burst in
January 2000—i.e., all the liquidity pumped into the system by
the Fed from Y2K scare onward has basically been chasing its
tail, leaving banks and corporates with more and more excess,
unused cash that was not being re-cycled into the real
economy.

The wonkish explanation is BmV = PY, (where B = the monetary
base, m = the money multiplier, V = velocity of money), PY is
nominal GDP. In other words, the massive amounts of central bank
monetary stimulus provided by the Fed and other central banks
since the 2008 financial crisis have merely worked to offset the
deflationary/recessionary impact of a collapsing money multiplier
and velocity of money, but have not had a significant, lasting
impact on nominal GDP or unemployment.

The only verifiable beneficial impact of QE, as in the case
of Japan over a decade ago and the U.S. today is the
stabilization of the banking system. But it is clear from the
above measures and overall economic activity that monetary policy
actions have been far less effective, and may even have been
detrimental in terms of deflationary pressures by encouraging
excess bank reserves. Until the money multiplier and velocity of
money begin to re-expand, there will be no sustainable growth of
credit, jobs, consumption, housing; i.e., real economic activity.
By the same token, the speed of the recovery is dependent upon
how rapidly the private sector cleanses their balance sheets of
toxic assets.

QE falls into a black hole. And it leads into
an - if possible even larger - black hole. Ben Bernanke and Mario
Draghi have neither the power nor the tools to stop deleveraging
and debt deflation. That's just a myth they, and many with them
who stand to benefit from that myth, like you to continue
believing. It makes it all that much easier for them.

That surge in excess bank reserves (see the second graph above)
comes from QE. It is your money, everyone's money. And it does
nothing to "heal" the economy you live in and depend on for your
survival; it just takes away more of it all the time. That is the
one thing Ben and Mario have power over: they can give money away
that you will have to pay for down the line. They can lend it out
to banks knowing that it will never be repaid, and not care one
inch. Knowing meanwhile that you won't either, because you don't
look at what's down the line, you look at today, and today
everything looks fine. Except for that graph, perhaps, but hey,
how many people are there who understand what it says?

One thing Ben and Mario can not do, however, is create
hyperinflation. They can't even truly create any type of real
inflation (which is money/credit supply x velocity vs goods and
services), for that matter. They're stuck as much as you yourself
are in the dynamics of this bursting bubble.

At The Automatic Earth, Nicole - Stoneleigh - Foss and I have
been saying for years that deleveraging and debt deflation are an
inevitable consequence of what went before and an equally
inevitable precursor of anything that may come after. And I have
often said that the deleveraging will be so severe that what may
come after is only moderately interesting, since you won't hardly
recognize your world once deflation has run its course.
Apparently this is hard to understand, the hyperinflation myth
just won't die. What can I say? Time to get serious.